By Tiernan Ray

Deutsche Bank hardware analyst Sherri Scribner this morning kicked off coverage of multiple hardware names, warning that pressure on IT budgets is separating winners from losers, with Apple (AAPL), EMC (EMC), and Hewlett-Packard (HPQ) being the winners and International Business Machines (IBM) and NetApp (NTAP) being losers.

Scribner sees a world in which virtualization has cut sales of server computers, with storage equipment being the next category that’s about to be gutted, while upside will come from cloud computing, Big Data technology, and “infrastructure and mobility.”

IT spending is no longer following the rule of two time GDP growth, she notes:

While a general rule of thumb used to be that IT spending would grow at 2x GDP, this metric appears to have contracted. IDC estimates that total IT spending has generally decelerated, from a high of 9.8% in 2004 to 4.8% in 2013 (global GDP grew 4.9% and 2.8% in 2004 and 2013, respectively).

After two years of server sales declining, Scribner sees storage as the next victim:

Unlike servers, which have seen negative growth over the past two years due in part to trends like virtualization, the storage market continues to see good growth. However we believe the storage market is just now beginning to be pressured by the need to better utilize existing storage hardware. Enterprises today operate in an environment where increasing the amount of storage means increasing personnel costs at the same rate, an unsustainable model when data is growing at rates of 40-60%. Just as server virtualization is targeting taking full advantage of the processing power of servers, the goal of software defined storage (SDS) is to better utilize the disparate storage resources in a datacenter in order to better manage and control storage growth. We expect the impact of SDS strategies by enterprises to be a negative drag on storage growth over the next few years, although we see this as somewhat offset by continued data growth.

She scouts the landscape of so-called “software-defined storage”:

The SDS market is still in its early phases, with a number of companies’ only recently announcing solutions (or detailing their product road maps) in this space. IBM has initiated a “Software Defined Environment” division, under which the company’s SAN Volume Controller (SVC), Storwize and XIV storage solutions are all SDS-ready. Separately, EMC’s ViPR solution marked its formal entry to the SDS market in May 2013. ViPR abstracts, pools and automates heterogeneous, traditional and emerging storage resources with a simplified interface (integrated with Openstack, vCloud, etc.). HP is also a key player in the SDS arena, with the company’s StoreVirtual VSA solution being introduced to the market in 2007.

Cloud computing is still just a small part of IT spending, but growing faster:

By most estimates, public and hosted private clouds remain a small percentage of IT spending today with $15.5B spent on public and hosted private cloud hardware in 2013, making cloud roughly 10% of total IT spending on server, storage and networking. While the percentage remains small today, this segment is growing 18% and represented all of the growth in enterprise IT hardware sales in 2013. Our conversations with industry professionals suggest that cloud is clearly changing how IT budgets are spent. In our view, cloud is a positive for hardware vendors due to its growth, but a negative for margins as cloud providers tend to favor commodity hardware. There is also a risk of cannibalization by cloud providers who build their own hardware solutions, however the number of companies doing this is small today, but it does include large providers like Amazon and Google.

Meantime, so-called “converged” systems, that marry servers and storage and networking, will take over a greater and greater portion of mainstream workloads, she opines. Scribner references several examples of such converged infrastructure:

Technology for Big Data may grow much faster than other segments of IT spending, both on the hardware and the software side:

Hardware, which includes servers, storage, networking and cloud infrastructure, is expected to see the largest growth, increasing at a CAGR of 33% from 2012 to 2017E. Software is expected to grow at a CAGR of 21% while services are expected to grow at a CAGR of 23% during this period, as seen in Figure 31. In total, the market is expected to grow at a CAGR of 28% from 2011 to 2017E. As a percentage of total server, storage and networking spending, Big Data represented roughly 4% of IT hardware spending in 2013, but this is expected to increase to 10% of IT hardware spending by 2017.

Scribner starts EMC at a Buy, with a $32 price target, writing that it is the “big dog” in Big Data. EMC is already beating the overall storage market growth rates, and seems well set-up for the move to software-defined storage:

EMC continues to outgrow the overall storage market and remains the storage market share leader with roughly 25% share. Over the past few years, storage growth has slowed, with industry revenue declining 2% in 2013. However, EMC continues to outperform the overall market, with EMC’s revenue up 7% in 2013, reflecting the value of its key VMAX and midrange offerings within the context of a challenging IT demand environment […] We believe the storage market is being pressured by the need to better utilize existing storage hardware. Breaking the linear link between increasing storage capacity and increasing personnel costs is a key business imperative, particularly when data is growing at rates of 40-60%. EMC is well positioned for the trend towards software defined storage (SDS) with its ViPR offering and Project Nile. In addition, EMC’s Big Data Analytics platform Pivotal should be a material growth driver going forward, as businesses try to derive useful information from the vast amounts of data collected from customers.

In contrast, “NetApp’s medium-sized businesses are exploring putting more workloads in the Cloud,” Scribner believes, crimping the company’s growth. She starts the stock at a Hold, with a $36 price target.

It’s not clear the company’s “ONTAP” product will be able to make the transition in the storage market:

We believe the functionality of NetApp’s Clustered Data ONTAP is an attractive offering for cloud service providers, however it is still unclear how significant this business will be for NetApp over time or if the software will drive growth in the company’s storage products. Clustered Data ONTAP offers attractive features for cloud service providers like non-disruptive operations and high scalability under multi-tenant architectures, and we believe adoption will increase, but we do not view this as a near-term catalyst.

As for IBM, which she starts at Hold with a $200 price target, growth is “challenged” for the company, and that doesn’t look to be changing anytime soon:

From 2010 to 2013, IBM’s revenue has been essentially flat at $100B. In addition, sales have declined for the past 7 quarters, with declines seen in all of the company’s segments except for software. Systems revenue in particular has been hard hit, driven in part by the waning of the mainframe cycle, although weakness was across all of the company’s hardware lines, including Power, x86, and storage. Going forward we expect hardware revenue to continue to be challenged, driving overall revenue down modestly in FY-14. Given its large size, we would expect growth to continue to be difficult, and are modeling long-term growth in the 1-2% range.

I’ll have more on Apple and HP in another note, but a little can be said about her overall view on the two: for Apple, which she starts at a Buy, with a $650 price target, the company’s devices are the “gold standard” in smartphones and tablets, and “These segments continue to offer good growth, allowing Apple to outgrow overall IT spending, with upside coming from the potential for a larger screen sized phone. We also view new product introductions as a long-term growth driver, which are not reflected in our model.”

For Hewlett, although it is still searching for a next act in its turnaround, “While the company does have a higher mix of declining segments like PCs and printers, we believe HP’s IT hardware portfolio is well positioned for the next phase of IT, with strength in converged infrastructure and Big Data,” writes Scribner. She starts the stock at a Buy with a $40 price target.

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There are 4 comments

APRIL 10, 2014 2:26 P.M.

Sal wrote:

Apple sucks!

APRIL 10, 2014 5:12 P.M.

Bud U. wrote:

I agree with the EMC story. Remember they own 80% of VMW, which is trading at over $100/sh. EMC is undervalued at this point. Trading at 14X 2014 earnings.

APRIL 10, 2014 6:18 P.M.

Paul wrote:

The quality names really fared pretty well today. Valuation really does matter. On that front Apple looks solid ... so I bought more. It won't make me filthy rich but will pay me a nice yield and gain over the next couple of years. DB's $650 price target seems about spot on particularly with them continuing to make money hand over fist and buy back their shares.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.